Imperfect price adjustment and the optimal assignment of monetary and fiscal policies

The paper considers the coordination of monetary and fiscal policy for a closed economy with the following properties: a Keynesian short-run, a classical steady state and serially correlated price adjustment. Given a set of plausible targets, the system is perfectly controllable in the sense of Aoki (1975) only when it is in the classical long-run equilibrium. The imperfect controllability outside the steady state is due to the inertia in the inflationary process. The paper derives a stabilization program which characterizes the optimal response of policy in light of the price adjustment mechanism. The resulting assignment of instruments is an interesting alteration of Mundell's (1962) formula.